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Should You Buy Energy ETFs On Dip?

·6 min read

The energy sector has been witnessing wild swings, largely driven by volatility in oil price. This is especially true as oil price slid to a seven-month low on Sep 7, trading on renewed demand fears and rate hike speculations. In fact, Brent crude dropped below $90 per barrel for the first time since Feb 8, while West Texas Intermediate plunged to a low of $85.17, the lowest since Jan 26.

For the week, both benchmarks were down about 4%, sending energy ETFs in red. SPDR S&P Oil & Gas Exploration & Production ETF XOP, Invesco DWA Energy Momentum ETF PXI, First Trust Natural Gas ETF FCG, Invesco S&P SmallCap Energy ETF PSCE and Invesco Dynamic Energy Exploration & Production ETF PXE have lost more than 4% each over the past week.

The oil slump came amid waning demand. The Fed’s aggressive rate hikes have sparked fears of recession, thereby resulting in lower demand. Higher interest rates will drive the U.S. dollar upward, making dollar-denominated assets more expensive for foreign investors and thus dampening the appeal of the commodity. In addition, it will make the borrowings, in particular for high-yield firms, costlier and result in less money flowing into capital-intensive shale oil and gas drilling projects. This, in turn, will lead to higher bankruptcies, hitting the energy sector.

Additionally, Russian president Vladimir Putin threatened to cut off the energy supply if price limits are imposed by the West on Russia's oil and gas exports. China has also implemented a zero-COVID policy, leading to full or partial lockdowns in more than 70 cities since late August, which has threatened oil demand. Growing fears of a recession in Europe are also impacting the demand for energy (read: More Pain Ahead for Energy ETFs?).

We profiled the above-mentioned ETFs below:

SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

SPDR S&P Oil & Gas Exploration & Production ETF provides exposure to 61 oil and gas exploration and production companies by tracking the S&P Oil & Gas Exploration & Production Select Industry Index.

SPDR S&P Oil & Gas Exploration & Production ETF has AUM of $4.5 billion and trades in an average daily volume of 6 million shares. The fund charges 35 bps in fees per year and has a Zacks ETF Rank #1 (Strong Buy) with a High risk outlook.

Invesco DWA Energy Momentum ETF (PXI)

Invesco DWA Energy Momentum ETF tracks the Dorsey Wright Energy Technical Leaders Index, which is designed to identify companies that are showing relative strength (momentum). The fund has 36 stocks in its basket with AUM of $225.8 million (read: 5 Momentum ETFs Riding on the Surge in Market).

Invesco DWA Energy Momentum ETF charges 60 bps in annual fees and trades in a good volume of 42,000 shares a day on average. PXI has a Zacks ETF Rank #1 with a High risk outlook.

First Trust Natural Gas ETF (FCG)

First Trust ISE-Revere Natural Gas Index Fund offers exposure to U.S. companies that derive a substantial portion of their revenues from the exploration and production of natural gas. It follows the ISE-REVERE Natural Gas Index and holds 49 stocks in its basket.

First Trust ISE-Revere Natural Gas Index Fund has amassed $917.8 million in its asset base while charging 60 bps in annual fees. Volume is good, with 1.1 million shares exchanged per day, on average. The product has a Zacks ETF Rank #2 (Buy) with a High risk outlook.

Invesco S&P SmallCap Energy ETF (PSCE)

Invesco S&P SmallCap Energy ETF offers exposure to the companies that are principally engaged in producing, distributing or servicing energy-related products, including oil and gas exploration and production, refining, oil services and pipelines. It tracks the S&P Small Cap 600 Capped Energy Index, holding 28 stocks in its basket.

Invesco S&P SmallCap Energy ETF has accumulated $134.5 million in its asset base and charges 29 bps in annual fees. It trades in an average daily volume of 237,000 shares and has a Zacks ETF Rank #2 with a High risk outlook.

Invesco Dynamic Energy Exploration & Production ETF (PXE)

Invesco Dynamic Energy Exploration & Production ETF follows the Dynamic Energy Exploration & Production Intellidex Index, which thoroughly evaluates companies involved in the exploration and production of natural resources used to produce energy based on a variety of investment merit criteria, including price momentum, earnings momentum, quality, management action and value.

Holding 32 stocks in its basket, Invesco Dynamic Energy Exploration & Production ETF has amassed $287.4 million in its asset base and charges 63 bps in annual fees. It trades in a volume of 167,000 shares and has a Zacks ETF Rank #1 with a High risk outlook.

What Lies Ahead?

Despite the slide in recent weeks, oil price is up 10% from a year-to-date look. The outlook for the sector still looks promising, given OPEC new output cut and the unrest in Libya that will continue to keep supply in check.

The OPEC has decided to cut oil output by 100,000 barrels per day in October in the latest meeting. Global oil supply could take a hit as the peak U.S. hurricane season approaches. This will provide an upward thrust to the sector in the coming weeks.

According to Bill Smead, chief investment officer at Smead Capital Management, investors should buy oil stocks as energy prices are likely to increase. Demand will likely spring back when more movement restrictions in China are eased. Further, the United States is bracing for a busy hurricane season, when supply constraints will emerge again and push oil price higher

Further, the oil futures market is in a state of backwardation, where later-dated contracts are cheaper than near-term contracts. This signals that the oil market is tightening and demand is robust, paving the way for an oil rally. This trend is likely to persist at least in the near term, acting as the biggest catalyst for the commodity.

Moreover, the above-mentioned ETFs have a Zacks ETF Rank #1 or 2, suggesting that these have the potential to outperform in the coming months. Almost 80% of the industries in this sector are top-ranked, with Refining and Marketing, Exploration and Production – Canadian, Field Services, and Drilling having an Industry Rank in the top 10% (read: 4 Top-Ranked Sector ETFs to Buy Now).  

Given the solid outlook but somewhat bearish near-term sentiments, investors may want to consider staying on the sidelines for the time being. However, risk-tolerant long-term investors may want to consider this recent slump a buying opportunity, should they have the patience for extreme volatility.


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SPDR S&P Oil & Gas Exploration & Production ETF (XOP): ETF Research Reports
 
First Trust Natural Gas ETF (FCG): ETF Research Reports
 
Invesco S&P SmallCap Energy ETF (PSCE): ETF Research Reports
 
Invesco DWA Energy Momentum ETF (PXI): ETF Research Reports
 
Invesco Dynamic Energy Exploration & Production ETF (PXE): ETF Research Reports
 
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